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Avoiding the Pitfalls: Invest in Skills for Deal Evaluation

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This article is sponsored by The Wharton School.

Venture and private equity investment are important components of the portfolios of sovereign wealth funds (SWFs). However, access to these asset classes has come with hefty management fees. For SWFs, there are several advantages to direct investment in venture and private equity deals. Direct investment allows more control over the timing of actual investments. It also allows the SWFs to have more flexibility in their portfolio construction. And most importantly, there are significant savings on management and performance fees.

SWF managers need to be adept at analyzing whether their returns will beat the realized return (after fees) offered by venture capital and private equity firms. Unfortunately, ample evidence has shown that this can be very challenging for many SWFs making direct investments. The sources of these challenges vary across venture capital and private equity deals.

To date, SWFs’ investments still lag behind the performance of private equity firms. This brings us to the issue of know-how.

Venture investments often require a judgment call on the management team, because of a lack of tangible assets and reliable market data, and a paucity of concrete information about how the company will perform. Furthermore, in recent years, venture investments frequently suffer from what is known as the winner’s curse. If a deal becomes available to SWF managers, it is likely that it has already been turned down by many sophisticated venture funds. To “win” these deals may actually damage (or “curse”) an SWF portfolio.

In contrast, SWFs have relatively more access to deal flow in private equity deals. Fund managers are able to evaluate these investments at a higher level through information gathering and commercial due diligence.

To date, SWFs’ investments still lag behind the performance of private equity firms. This brings us to the issue of know-how. Is it possible for SWFs to hire the right personnel or train their staff so that they can mimic the general partners who lead private equity firms on sourcing and commercial due diligence? What are the best practices used by leading general partners when they source deals? What are the return drivers as private equity firms evaluate deals in their search for value creation?

Wharton’s new four-day executive education program for industry professionals, Private Equity: Investing and Creating Value, provides a highly focused program to address these issues. “Sovereign wealth fund managers will receive training on due diligence, how to structure a private equity deal, and how to think like private equity firms,” says Wharton Private Equity Professor Bilge Yilmaz. “This will give them an advantage when partnering or even competing with private equity firms. We hope that SWFs will see this program as a smart investment.”

“This is a unique opportunity to make an investment in your skills,” adds Yilmaz. “You will tap into the expertise of some of the top senior partners in leading investment organizations, who will not only share the latest trends, but also evaluate deals that participants put together. You will learn how they add and create value, and how the private equity business model varies as a result of regulations and market forces in different countries and regions. SWF managers in particular, as they increasingly move toward direct investments, need this kind of knowledge now.”

 
 
 
 

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Transforming Saudi Arabia’s Capital Markets

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This article is sponsored by State Street.

KEY POINTS

– Vision 2030 and the Aramco privatization mark a decisive point to advance Saudi Arabia’s financial sector — a critical ingredient to the country’s economic transformation

– Saudi’s “Financial Triad” remains partially incomplete with a sound banking system and a rapidly emerging equity market, but an immature bond market.

– The privatization of Saudi state assets (including Aramco) could deliver a boost to the depth and sophistication of the Saudi equity market and — if cleverly designed— have positive spillover effects into other areas of finance and policy.

– The timing is ideal to launch an accompanying systematic drive to build local currency bond markets, which is a prerequisite for achieving the broader economic goals of Vision 2030.

Saudi Arabia’s Vision 2030 is remarkable in its aspiration to engineer far-reaching economic transformation. As a global asset manager, we note that one of the three pillars of this vision sets out the aim to make the country a “global investment powerhouse.” 1

While Saudi Arabia has a strong legacy as a sovereign investor in foreign markets, this ambition also requires its local financial system to deepen across all sectors. Strong capital markets work together with a banking system to channel investment and ensure efficient capital allocation across the economy. In the absence of such channels, many worthwhile business ventures never take place, capital is misallocated and underutilized, and economic growth remains below its potential.

To read the full study please click here.

1 Foreword to Vision 2030, http://vision2030.gov.sa/en/foreword.

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Sovereign Wealth Funds as a Driver of African Development

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This article is sponsored by Quantum Global.

Sovereign wealth funds (SWFs) are becoming important sources of development in many countries. African SWFs have been growing in recent years, as many countries joined the international trend in establishing SWFs, while many others are preparing to join. Growth of SWFs has been driven by rising commodity prices until 2014 and improving economic growth rates. At the same time, Africa continues to face a number of development challenges, raising the question of whether SWFs can play a role in fostering economic development on the continent. This paper analyses the dynamics and role of SWFs in promoting development in Africa. The paper notes that SWFs can play a more active role in Africa’s development by bridging the infrastructure funding gap, supporting industrial development and economic diversification, reducing macroeconomic volatility and enhancing intergenerational equity. For SWFs to be effective in delivering their mandates and supporting economic development, they need to have clear goals and objectives, improve their governance and transparency frameworks, improve their risk management frameworks and embrace the Santiago Principles. African governments need to develop more attractive frameworks and climates for SWFs to invest in the continent, especially in sectors that contribute more directly to addressing Africa’s development needs.

To read the full study please click here.

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Collateral: The New Performance Driver

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This article is sponsored by BNY Mellon.

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In 2017, the global buy-side community faces considerable liquidity and funding pressures, stemming from market and regulatory reforms that are causing disruption. As a result, access to high-quality collateral, funding and liquidity is not only a pressing concern but has emerged as the essential new performance driver for the buy-side.

This disruption is the result of two opposing forces. Stringent regulatory requirements are forcing market participants to seek collateral — generally of high quality — in order to secure trading exposures. At the same time, the sell-side — or dealer-sponsored financial plumbing used to supply liquidity and collateral to the market — is experiencing challenges due to Basel III capital and liquidity constraints.

A major concern among multiple buy-side firms is that the next market-stress event will occur not because of a lack of collateral in the financial system but rather due to the inaccessibility of this collateral.¹ This scenario is forcing firms to reevaluate their collateralized trading portfolios, recalibrate asset allocation strategies and in some cases review the investment products offered to end clients.

This paper presents the findings from BNY Mellon–PwC outreach to senior buy-side executives from over 120 global firms conducted during the first quarter of 2017. It provides insights on demand-supply imbalances that are being experienced by buyside firms and the possible solutions they are exploring in response to fears that ready access to liquidity and high-quality collateral may become scarce in the years ahead.

The picture that emerged from these discussions was one of a buy-side community both grappling to adjust to its new collateralized trading obligations as well as striving to secure access to sustainable sources of funding and liquidity.

To read the full study please click here.

1. Collateral can be inaccessible due to decreasing velocity of collateral, which indicates how much, on average, a single dollar of collateral is reused over a period of time. This is analogous to the concept of “velocity of money.”

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